Should I Invest In BAE Systems Plc Now?

The US and UK national defence budgets are important to firms such as BAE Systems (LSE: BA) (NASDAQOTH: BAESY.US), purveyors and manufacturers of some of the world’s finest and most effective fighter planes, radar, attack missiles, warships and munitions.
Last year, 37% of the firm’s sales were to the US, 26% to the UK and 20% to Saudi Arabia, so it’s reassuring to learn from BAE Systems’ CEO that the US defence budget, although indicating spending reductions, points to a more predictable outlook than the firm has seen in recent years.

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The US and UK national defence budgets are important to firms such as BAE Systems(LSE: BA) (NASDAQOTH: BAESY.US), purveyors and manufacturers of some of the world’s finest and most effective fighter planes, radar, attack missiles, warships and munitions.

Last year, 37% of the firm’s sales were to the US, 26% to the UK and 20% to Saudi Arabia, so it’s reassuring to learn from BAE Systems’ CEO that the US defence budget, although indicating spending reductions, points to a more predictable outlook than the firm has seen in recent years.

A few big customers

Although there always seems to be a constant stream of contract-win announcements at BAE Systems these days, the reality is that most of the firm’s business comes from three big sovereign government customers. That means that BAE Systems’ roughly £43bn order book carries some risk, because the firm’s big customers carry a disproportionate amount of power. A change of buying policy or fluctuating political diktat could scupper the firms shot at a profit in any trading period.

The CEO reckons that in the UK, long-term, stable contracts in the maritime and military air sectors continue to support the company’s operations, providing forward earnings’ visibility. He also speaks favourably of the firm’s progress in other international markets but, last year, international sales outside the big three regions only came in at 17% of the total, so there’s a long way to go before investors can get over-excited about that.

Depressingly steady business

Despite BAE Systems’ line of business, I think it unlikely the shares will ever shoot the lights out.

Most investors seem attracted to the shares for its steady cash flow generated from constant demand for its products, which the firm uses to pay an escalating dividend:

Year to December

2009

2010

2011

2012

2013

Revenue (£m)

20,374

20,980

17,770

16,620

16,864

Adjusted earnings per share

40.1p

39.8p

45.6p

38.9p

42p

Dividend per share

16p

17.5p

18.8p

19.5p

20.1p

Such a long tradition in annual dividend raising seems something that top management will be reluctant to break. Taking that with the propensity of various segments of the world’s human population to keep killing each other, and the firm’s bulging order book, BAE Systems looks like an attractive dividend play in the defence sector.

What now?

At a share price of 429p, the forward dividend yield is running at about 4.9% for 2015, and city analysts expect forward earnings to cover the payout around 1.9 times.

BAE Systems’ dividend is tempting, but I look for shares that also have good prospects for capital growth, which is a battle I think the firm will find harder to win.

One company is a largely ignored small cap trading at an irresistible discount. There's a play on technology focused high-tech defence applications, and the third share provides a fundamental vehicle to ride emerging-market potential.

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